TMFPostOfTheDay (< 20)

Dollar in a Liquidity Trap?

10

"...As long as the euro is falling, and as long as investors must raise cash because of margin calls, the dollar price of gold will fall..."

Wendy, you have brought up a critical point, and it's tied to a previous post. It was a post on the velocity of money.

IMHO the dollar is in, well, a liquidity trap. And the evidence is seen daily in US Treasuries: there has been a flood of 'sweetened' Fed cash into this economy, yet on the short end interest rates are at or near zero at auction, and I can't imagine how much of that market has negative yield to maturity, and that seems to fit the definition.

My own opinion on this is that these methods of quantitative easing are useless in a global digitally connected algorithmically driven economy.

(And this abhorrent technology, I dare say, might in fact save the EU, but not the Euro; explanation below.)

First a few observations: It has become clear that the tap of EU bailout money is running dry. The ECB cannot leverage up 5 to 1. The IMF will not get more 'contributions' for a back-door bailout. (I think the Fed said today that there would be no Fed bailing for Eurozone failures). The ECB has put an upper limit on sovereign bond support. The UK flat out refused to be a part of EU taxation. The well has run dry.

Lastly, and towards the point, it is a well known fact that these troubled sovereigns have large gold reserves.

I don't think that gold declined because the Euro declined. Quite the opposite. The Euro declined because gold declined.

Since so much debt must be rolled over early in 2012, I'm thinking that it's troubled sovereign governments selling gold. And never mind to service debt! Imagine the outcry of these governments can't meet their domestic obligations!!

I think that today's 5% gold drop might be the first of several desperate attempts to sell assets, for cash : USD cash! Naturally, such a decline in gold would create margin calls in the futures market in general. And once those trades are settled I doubt that those dollars will be converted back to Euros.

In spite of a rating agency downgrade, massive Fed liquidity injection, dollars are still, still, still being hoarded or being put into Treasuries.

And thus I answer your question : The dollar, by far and away, the safest of the aforementioned assets. (the lesser of the evils, if you will). If, big IF, if it is sovereign gold wealth being sold, it could possibly turn into a 'run' on gold as everyone heads for the exit asap. (And that could 'scale up' in every iteration.... and fast, fast, fast).

If so, the dollar would have considerable gains. In fact, let me ask a question : If the S&P can un-do ten years of gains, can the dollar undo ten years of decreasing purchasing power? Hence begs the question : could purchasing power be cyclical over the very long term?? Are inflation and deflation two sides of one coin?

I can't help but get the feeling that we're looking over our shoulders trying to out run a past horror when the unrealized dangers, are ahead of us.

One last note about the Euro. It came to soon and technology has made a regional single currency obsolete. Think about it : if all the old Eurozone currencies were still in place, very fast, globally connected algorithmic methods could at any given instant, create a 'designer basket' of currencies optimized for each specific cross border transaction.

That is to say a synthetic Euro could be created for each specific cross border transaction.... and then unwound.